Monday, 13 September 2010

Correlated risks

During the 2008 election campaign, Key advocated having the New Zealand Superfund invest up to 40% of its assets in New Zealand. This seemed utterly absurd. Superfund investments will be drawn on when domestic tax revenues are low and superannuitant commitments are high. When will domestic tax revenues be low? During a domestic recession. When are NZ investments worth least? During a domestic recession. Since overall government funding of superannuitants will come from a mix of domestic tax revenue and returns from the investment portfolio, a sensible strategy would underweight domestic investments relative to international ones to avoid correlated shocks.

When Bill English asked whether the Superfund could massively increase its domestic holdings without compromising its duty to invest the fund on a prudent, commercial basis, the managers of the fund told him no.

NotPC reports that the Earthquake Commission has invested heavily in domestic assets - mostly government stocks and bonds. 67% of its asset base is government securities. Some of this would be an artefact of the financial crisis with different parts of the asset base having different responses. But it does seem very high.

Again, correlated risks. The Christchurch earthquake is going to be expensive, but it could have been much worse. Something much worse would have nailed NZ's credit rating and killed the value of a good part of the commission's asset base at the exact time it would need to liquidate it to pay out on claims.

Suppose that your wife tells you that you could save a lot on house insurance if you just paid her the premiums every month and she'd pay you if the house burned down. Seems like a good idea - keep the money in the family. She invests the premiums you pay her in getting the kitchen redone. Yup, the insurer's asset base looks good now. But come the fire...

Hopefully it's not as bad as all that. If they're clever, the reinsurance picks up everything beyond some minimal amount, so the Earthquake Commission's asset base only needs to cover what would effectively be a deductible. In that case, heavy domestic investment in government assets is silly rather than reckless.


  1. I'd go a step further and ponder whether the revelation that comes out now (that 70% of the EQC fund is invested in the NZ Govt), is not in fact something of a scam (for want of not being too blunt). One could argue that the compulsory payments into that fund have in fact been a tax on insurance and that paying out on the "insurance" provided by that tax is in fact deferred to our children and grandchildren, as is the case with just about any government "investment" or social service.

  2. I seem to remember a Listener article about 10 years ago commenting on the fact that the government was effectively taking the funds from the EQC and handing over government debt in return (that's my hazy recollection of the article anyway) - at the time the comment was that this didn't seem very clever for the reasons you've mentioned...hopefully we'll see an improvement in the balance of the portfolio post-Christchurch.

  3. Ten years ago would be about right; the change allowing such investment was in 2001.